"It's sleazy, illegal, and could be the future of retirement"--Tontines

[samclem]

This is an interesting article on tontines in the WashPo. From the article:

Some academics even argue that with a few new upgrades, a modern tontine would be particularly suited to soothing the frustrations of 21st-century retirement. It could help people properly finance their final years of life, a time that is often wracked with terribly irrational choices. Tontines could even be a cheaper, less risky way for companies to resurrect the pension.
“This might be the iPhone of retirement products,” says Moshe Milevsky, an associate professor of finance at York University in Toronto who has become one of the tontine’s most outspoken boosters.
. . .


A simple modern tontine might look like this: At retirement, you and a bunch of other people each chip in $2o,000 to buy a ton of mutual funds or stocks or whatever. Every year, the group withdraws a predetermined amount and divides it among the remaining survivors. You might get a bonus one year, for instance, because Frank and Denise died.

The article indicates a tontine payout could be 10-20% higher than an annuity, primarily due to decreased costs.
I think tontines could be a great product, for many people, if the safeguards were in place. But they are still largely illegal.
We've touched on tontines in the past (several posts in each thread)
Here
Here

Anyway, maybe somebody will find a way to bring these products to market.

 

[timo2]

Agatha Christie could have made a nice little murder mystery out of a Tontine group.

 

[bingybear]

Agatha Christie could have made a nice little murder mystery out of a Tontine group.

yes it could... but even without that concept....

Not sure I would jump into one. I think one needs to grab all the long lived people for this... short lived will just loose. Now of days there is likely more information on longevity than in 1900. But then again, maybe not well known for many of us. If one was setup blind, you would not have an estimate of the longevity distribution of participants.

 

[timo2]

yes it could... but even without that concept....

Not sure I would jump into one. I think one needs to grab all the long lived people for this... short lived will just loose. Now of days there is likely more information on longevity than in 1900. But then again, maybe not well known for many of us. If one was setup blind, you would not have an estimate of the longevity distribution of participants.

You are right about more information about longevity now ruining the deal. Unless you set up a fantasy tontines pool, and got to pick people based upon their genes ;-)

 

[JPatrick]

Near impossible to do I guess, but a ton of back testing results would be nice to look at.
I think those who wish to leave something for family could be accommodated through a hold back of a portion of their share.

 

[urn2bfree]

Robert Louis Stevenson wrote a novella about a tontine called The Wrong Box which was turned into a funny/strange 1960’s comedy farce starring Michael Caine, Peter Sellars, Dudley Moore, John Mills and Ralph Richardson. TCM has shown it occasionally.


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[chris2008]

It looks like the reverse concept of life insurance, with very little corporate overhead.

 

[Masquernom]

I was wondering how these are set up. Does everyone in a tontine have to be the same age? How about the difference between women and men? If most of the people are age 50, you wouldn't want a 25 year old buying in. They'd be certain to get it all. Just curious what the original rules were for setting them up.

 

[donheff]

Humm. Who knows. It would need a lot of regulation to avoid fraud. And what would be the business model for the tontine organizer to make money? I imagine it would have to be some offshoot from standard annuity providers - so by the time products actually appeared they would be not much better than annuities (if any better).

 

[bingybear]

Humm. Who knows. It would need a lot of regulation to avoid fraud. And what would be the business model for the tontine organizer to make money? I imagine it would have to be some offshoot from standard annuity providers - so by the time products actually appeared they would be not much better than annuities (if any better).

If you built this like an annuity (logical idea), would this not really be like a joint annuity (many participants) that has equal payouts for life of the longest lived. This is done for couples and the result is the payout usually goes down because of the odds of longer payouts.
So the annuity company would make out and the longer lived likely too.

now even less interested

 

[petershk]

I thought a tontine was that thing Han Solo cuts open to keep Luke from freezing in Empire?

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[MichaelB]

Interesting article, thanks for posting it. From the link

A simple modern tontine might look like this: At retirement, you and a bunch of other people each chip in $2o,000 to buy a ton of mutual funds or stocks or whatever.

This isn't like an annuity, it's like a pension fund, which has much broader options (compared with annuities) for investing the assets. Properly regulated, this could be an interesting alternative for retirees that have little or no annuity income. A pension fund can take on more portfolio risk compared with each individual member, so it offers a way to increase total return, and then use part of that return to finance the longevity risk.

The high returns, or course, imply that there is no partner survivor option.

 

[samclem]

Just curious what the original rules were for setting them up.

I dunno. But I'd go with something very simple--everyone of the same age (maybe an offset for gender), no medical underwriting. Bias the product toward being longevity insurance since that's what it would do best (due to the "mortality credits" and a "% of remaining balance" payout that increases with age, like the RMD tables) so, probably no payouts until age 75.
Yes, in a rational world we'd expect the product to attract healthier-than-average participants, but I don't know if the selection bias would be incredibly strong for a few reasons:
1) People would buy based on their perceived health relative to others, which might be different from reality.
2) People with poor health/unhealthy lifestyles need longevity insurance too. Few people know exactly when their meter is going to run out, regardless of what the averages say.

With no need to maintain big cash reserves/ultra conservative investments (esp many years before payouts begin) and lower overhead costs, we could expect a product like this to return a significantly higher % of clients' money and do a better job of providing for their old age than an annuity can.

 

[Marco]

Put me in coach, I'm ready to play!

 

[bingybear]

just looked up some stuff on tontines..

Each beneficiary was to receive an annual payment
based on the interest earned by the combined initial capital
contributed of investors in the applicable age cohort. The rate of interest
increased with the age of the nominee. As nominees died, the share
related to that nominee became worthless and the payments based on
each of other surviving nominees would increase. The subscriber
represented by the last nominee in each group would get all the interest
generated by the capital within that band. On the death of the last subscriber,
the capital would revert to the government.

taken from "Fordham Journal of Corporate &
Financial Law"
note that it was not the age and mortality of the subscriber, but of the nominee... a person chosen by the subscriber whose life the the payouts based.

Also note in that text the some cases finding against tontines did not state what law was violated.

Don't bet that all of the tontines are winner take all... more likely originator still takes much of it.

 

[harley]

I thought a tontine was that thing Han Solo cuts open to keep Luke from freezing in Empire?

Currently unavailable, just like the tontine.

 

[samclem]

Don't bet that all of the tontines are winner take all... more likely originator still takes much of it.

But a new product could be structured in just about any way. A "winner take all" lottery wouldn't be much of a practical financial product. A tontine that people could count on to start making regular payments when they turned 75 would allow them to spend more in the intervening years. This could be a useful product for the large number of people who have limited retirement savings--making the nest egg last for just 10 years or so, esp with some help from SS, is a lot more do-able than making it last for an unknown (but possibly long) life expectancy.
A tontine payout wouldn't have the guaranteed future monthly payment of an annuity, but what is that worth, anyway? If it's not inflation adjusted, then there's no telling what the firm, fixed payment 20 years in the future will really be worth, so it is not much of a guarantee. If it is inflation-adjusted, then the real growth rate is minuscule (largely because of the slow growth of the required very conservative investments).

 

[bingybear]

But a new product could be structured in just about any way. A "winner take all" lottery wouldn't be much of a practical financial product. A tontine that people could count on to start making regular payments when they turned 75 would allow them to spend more in the intervening years. This could be a useful product for the large number of people who have limited retirement savings--making the nest egg last for just 10 years or so, esp with some help from SS, is a lot more do-able than making it last for an unknown (but possibly long) life expectancy.
A tontine payout wouldn't have the guaranteed future monthly payment of an annuity, but what is that worth, anyway? If it's not inflation adjusted, then there's no telling what the firm, fixed payment 20 years in the future will really be worth, so it is not much of a guarantee. If it is inflation-adjusted, then the real growth rate is minuscule (largely because of the slow growth of the required very conservative investments).

you can buy annuities that will start making payments some years out... like you note (bold). But you keep noting tontine, so I assume you are wanting this to funnel deceased subscriber's benefits to the remaining subscribers. My term "winner take all" was intended to mean the last one standing gets the rest of the pot. I can see that as confusing.

But a new product could be structured in just about any way.

I don't believe this product can be done in the US. From the Nolo's Plain-English Law Dictionary

Tontine
An agreement in which investors receive annuity payments, with the special provision that when one participant dies, his or her share goes to the others (increasing the payments to the survivors). Generally, the last to die receives the remaining funds. They are illegal in the United States.

 

[CoolChange]

Since these seem to have originated in Europe, do you think there is any chance of seeing them revived there or other places with well regulated financial/investment/insurance industries? The USA definitely isn't the only place facing issues of financing retirements in the 21st century.

 

[samclem]

But you keep noting tontine, so I assume you are wanting this to funnel deceased subscriber's benefits to the remaining subscribers. My term "winner take all" was intended to mean the last one standing gets the rest of the pot. I can see that as confusing.

There's no particular reason it has to structured so that the pot goes to one last survivor. Just structure it so that the X% of the end-of-year balance every year (X increases in a fairly aggressive way each year as the cohort ages) is divided among all the surviving members. The thing could be set up in many different ways to distribute any remainder when the last member dies--there shouldn't be much money left, anyway if we choose the distribution rate appropriately. Heck, the thing could even be set up to distribute the entire pot to all survivors when the cohort reaches age 75, everybody gets a lump sum. They'd still do pretty well: Imagine that the tontine is sold to 55 year olds and liquidated when the cohort reaches age 75. About 1/3 of the people alive at age 55 will be dead by age 75, so the survivors would receive a check approx 1/3rd larger than they would have achieved through their own investments (on average). And probably even better than that--with no withdrawals for 20 years (unlike an individual portfolio), there's no "sequence of returns risk", so the fund can be invested in assets with greater volatility/expected return for the first decade or so, then transition to an AA with progressively less volatility.

I don't believe this product can be done in the US. From the Nolo's Plain-English Law Dictionary

Tontine
An agreement in which investors receive annuity payments, with the special provision that when one participant dies, his or her share goes to the others (increasing the payments to the survivors). Generally, the last to die receives the remaining funds. They are illegal in the United States.

There's some disagreement about that among sources I've seen. According to this paper (see pg 514), only SC and LA specifically prohibit tontines. And if we structure this product so that it benefits a large number of participants and accomplishes a legitimate goal rather than being a morbid winner-take-all death lottery, maybe the legal prohibitions would be avoided.
The point is to provide a product with advantages over existing deferred annuities, then people could decide if they want one, both, or neither.

 

[bingybear]

There's no particular reason it has to structured so that the pot goes to one last survivor. Just structure it so that the X% of the end-of-year balance every year (X increases in a fairly aggressive way each year as the cohort ages) is divided among all the surviving members. The thing could be set up in many different ways to distribute any remainder when the last member dies--there shouldn't be much money left, anyway if we choose the distribution rate appropriately. Heck, the thing could even be set up to distribute the entire pot to all survivors when the cohort reaches age 75, everybody gets a lump sum. They'd still do pretty well: Imagine that the tontine is sold to 55 year olds and liquidated when the cohort reaches age 75. About 1/3 of the people alive at age 55 will be dead by age 75, so the survivors would receive a check approx 1/3rd larger than they would have achieved through their own investments (on average). Not bad.


There's some disagreement about that among sources I've seen. According to this paper (see pg 509), only SC and LA specifically prohibit tontines. And if we structure this product so that it benefits a large number of participants and accomplishes a legitimate goal rather than being a morbid winner-take-all death lottery, maybe the legal prohibitions would be avoided.
The point is to provide a product with advantages over existing deferred annuities, then people could decide if they want one, both, or neither.

yes... I quoted that paper earlier including that some cases sided that tontines were illegal without siting actual laws. But in reading that reference you should note that the original goals were to fund other things like governments or projects more than return money to the subscribers.
As noted above, I still think the closest you'd get is a joint annuity.... and if they could put many many people on it. In this case the actuarial age for the last to die would increase and thus the payout would decrease (per year). Think of what happens with a pension when taking it individually or as a couple with 100% survivor benefit. Now you just keep adding people to the annuity (and yes, more contributions). Until many die off, you are much better using a regular annuity. Yes, those living longer would get more later on. They would also have to make up for the lower payments earlier including the effect of time and inflation.
I doubt the insurance industry will make the product that enticing to anyone other than very long lived people as the early payouts will be so much less than annuities or bond ladders. I also expect they will not want to deal with the legal aspects, that is proving it is legal prior to selling it. IMO
But maybe the US could us this as a way to pay out debt (again this was a proposal in the early years from that paper you referenced). Would you buy into that tontine in the present day? Could pay for entitlements and everything else!

 

[nun]

Interesting article, thanks for posting it. From the link This isn't like an annuity, it's like a pension fund, which has much broader options (compared with annuities) for investing the assets. Properly regulated, this could be an interesting alternative for retirees that have little or no annuity income. A pension fund can take on more portfolio risk compared with each individual member, so it offers a way to increase total return, and then use part of that return to finance the longevity risk.

The high returns, or course, imply that there is no partner survivor option.

The tontine is similar to an annuity as there is obviously a mortality credit.....but if the risk is spread amongst a small number of people there might be a temptation for members to speed the demise of other members. There'd be lots of opportunity for writers of crime fiction to come up with interesting plots set today rather than over a hundred years ago.

https://en.wikipedia.org/wiki/The_Wrong_Box_(novel)

So to Dickens and Mr. Mcawber we can add RLS and the Wrong Box to the list of literary financial references

 

[Independent]

There's no particular reason it has to structured so that the pot goes to one last survivor.

Right.

The OP references Milevsky. Here's his paper explaining a very structured idea:
[1307.2824] Optimal Retirement Tontines for the 21st Century: With Reference to Mortality Derivatives in 1693

Basically, a "sponsor" collects premiums from a group of (presumably) similar mortality risk people. The sponsor invests the money in laddered bonds. The sponsor guarantees a certain schedule of guaranteed total periodic payouts. The survivors at each payout date split that total amount.

The scheduled payouts decrease over time. The guaranteed total payouts conveniently mimic the projected number of survivors at each time in the future, according to some mortality table.

So, if people die exactly according to that table, each individual will experience level payouts over his/her lifetime. If they don't die according to the table, people will get higher or lower amounts.

Needless to say, the sponsor could set this up as a stock fund instead. In this case, the total periodic payouts would be some percent of the outstanding shares. As above, the percent varies over time and is calculated so that if the stocks yield exactly some rate and if people die exactly according to some table, then individual payouts will be level. Now actual payouts vary with two contingencies, investment returns and actual mortality.

I think I had another variation in one of the links you posted.

 

[samclem]

Basically, a "sponsor" collects premiums from a group of (presumably) similar mortality risk people. The sponsor invests the money in laddered bonds. The sponsor guarantees a certain schedule of guaranteed total periodic payouts. The survivors at each payout date split that total amount.

The scheduled payouts decrease over time. The guaranteed total payouts conveniently mimic the projected number of survivors at each time in the future, according to some mortality table.

So, if people die exactly according to that table, each individual will experience level payouts over his/her lifetime. If they don't die according to the table, people will get higher or lower amounts.

Thanks for finding that paper. So, would this provide more benefits to the participants than a conventional annuity? From the paper:

We have also shown that the utility loss from a properly designed tontine scheme is quite small when compared to an actuarially fair life annuity, which is the work-horse of the pension economics and lifecycle literature. In fact, the utility of from a tontine might actually be higher than the utility generated by a pure life annuity when the insurance
(commission, capital cost, etc.) loading exceeds 10%.

I'd be surprised if insurance companies take less than 10% off the top on their annuity products.

 

[Independent]

Thanks for finding that paper. So, would this provide more benefits to the participants than a conventional annuity? From the paper:

I'd be surprised if insurance companies take less than 10% off the top on their annuity products.

That's probably true, but much of what they take covers marketing, record keeping, customer service, accounting, compliance, capital ...

It seems to me that Milevsky's tontine would require all of those things.

The question is "What is the insurance company's load for the mortality guarantee?" That is the only service or activity that goes away in the tontine case.